Is it Time for You to Buy Shares and Not the Metal and Which Ones?

This is a snippet from a recent issue of the Gold Forecaster with Subscriber-only
parts excluded.

The gold price average over the last year has risen to close to the current
price. This means that the gold sales income of the mining companies has
persisted for long-enough for the mining companies to have income available
for payout to shareholders or to improve their Balance Sheet. This makes
mining companies with their leverage to the gold price more attractive than
the metal itself, currently. We let our subscribers know the shares we
believe will give them the greatest overall return on their investment, so
we restrict ourselves in this article to the underlying principles that guide
us in our choice.

Restraints on Large Investors

Many large funds need the shares they deal in to have a sufficiently high
market liquidity to accommodate the huge investment they have the potential
to make. Rather like sea-going liners that have large numbers of passengers
they cannot choose the smaller sail-boat like shares because it would be both
an insignificant investment and a difficult one to get out of if needs be were
the investment too large. So these companies often find themselves holding
shares that neither payout large dividends, nor see much overall impact from
a slightly higher gold price.

For investors capable of investing in smaller companies or companies on whom
a small increase in price will take the bottom line from a loss to a profit
[marginal mines] the choice of investment widens. So what principles should
guide such an investor in these gold shares?

Share Investment Principles for best overall returns

To set our minds to the right perspective, let's start by saying that
our investment should be able to do well in a bear market. It should
hold its value in bad times as well. Many believe that the gold market
is "too volatile" a place for investment funds. Following this principle
will remove many of the dangers that come from the [perceived] gold market.
You can be sure that when the markets turn bullish, these are the shares
that will outperform the rest. Nevertheless, the emphasis must be on holding
value in bear markets. Investors will outperform all others if this criterion
is rigidly followed.

This principle implies so much in the company. For instance if the gold
price were to hold still or fall, what will happen to its gold production
levels? In a junior mine which is growing its production and will do
so for many years the income to the company will continue to rise even
when the gold price falls. Most such mines therefore continue to see a
rise in profits in this situation, making it very desirable and falling-gold-price
resistant.

An examination of its "Break-Even Point" will tell you just how much
a rising gold price will benefit the percentage profit it will achieve.
If the next $50 rise in the gold price takes it into profit from a loss,
then it will run ahead of its peers in capital increase. If it is earning
say $300 profit on the gold price already then another $50 will only
increase profits another 16%, which is unlikely to make the share price
race.

Soundness of Balance Sheet almost goes without saying, it is so
important. When markets turn down and stress is brought to bear on the
company and ready outside capital is not so easily available [in a credit
crunch?], can the company fund such requirements internally or go to the
shareholders and get their support for the supply of capital?

Soundness of Shareholders implies more in a gold mine than in many
other sectors. Where the main shareholder is an important big gold mine
with a solid income stream and large capital base, there is a strong likelihood
that as the mine develops and grows the major mine will increase its stake
and or/ supply capital to ensure that growth continues. It's rather like
having a banker ready to supply interest free loans [shareholdings] ready
to maximize growth. The expertise of such shareholders is also available
to the mine management to ensure the best advice even to small companies.
Such support goes a very long way to ensure the success of the mine even
in the dark days of a bear market.

Can the company control its costs effectively or do they rise with
a rising gold price and stall when it falls? This asks one to look
at the shape of costs. How vulnerable to oil price rises will the company
be, or is it capital intensive. Will the Unions cripple profit levels
by excessive demands? In different countries this changes. In North America
mines are highly mechanized with a relatively small dependence on labor.
In others where labor is cheap wages can be a telling cost. Are the mines
disciplined enough to hold wage levels for one or two years at a time?
In the last three years the vulnerability to fuel costs was well demonstrated
in mechanized mines as the oil price rose to $145. In South Africa, the
incompetence of the Electricity Supply Commission in supplying power
has stalled growth. Now those same mines are racing to supply their own
power and lose their dependence on the company. Once this is in place
growth can resume and although electricity costs jumped to high levels
once-off, the threats to power supplies is being eliminated. A very long-term
mine such as South Deep of Goldfields [57 years?] becomes ideal in this
climate, but only for long-term large investors.

Exchange rates the mines receive their income in can play havoc
with profits. In a gold/platinum producing country like South Africa we
have seen the Rand rise alongside the rising gold price and largely neutralize
rising prices of the metal. There the mines pay their costs [labor intensive]
in Rands. They also receive their income from gold in Rands, without the
option of retaining them in foreign currencies. So not only has this lowered
their income, but allowed rising costs to reduce profitability. Where an
exchange rate is falling [such as the States and Canada] gold mines are
enjoying rising income with a rising gold price. The long-term view on
these currencies supports investments in these countries.

What is the potential [not so much their present] interference by the
government of the country in which the mine is based? When commodity
and metal price in general were surging before the credit crunch, we
witnessed growing greed on the part of the gold mining host nations with
a few exceptions. In countries like Mali, government interference is
minimal, but further afield saw governments ready to impose "Windfall
Taxes" on mining and other companies suddenly making huge profits. Profits
fell away under such fire. In South Africa, Royalties were and, I believe,
still are being worked out based not on profits, but on Turnover, making
profit potential extremely restricted. Is it any wonder that South African
gold production is moving to 200 tonnes a year from its peak in the past
of over 1,000 tonnes? Even U.S. Mining Laws are vulnerable at the moment,
so investors have to extend their analysis to this side of life too.
The worst that has happened is that government interference can lead
to the Nationalization of commodity producers as we have seen in South
America.

Dividend policy? It seems this subject is still largely a thing
of the past. We do feel that investors should know what a company's policy
on paying shareholders income for their investments will be at all times.
In days where rosy futures are things of the past income and capital values
will grab the attention of all investors and their investments will follow
paying companies. Once companies see their share prices benefit from good
dividend policies on what are wasting assets, then shareholder rewards
will gain favor. It is always as well to measure potential income growth
with fixed interest low risk debt instruments to assess the future value.
Rosy futures allowed for share prices to get out of hand in all sectors
until the credit crunch and then the pain set in! Income streams will help
to offset falling share prices and help companies to hold share price levels
even in bear markets! What good is an investment in a mining company where
they simply mine metal? If the shareholders are not rewarded why invest?

Competence of Management. Management with good professional records
on the mining front and the financial front will ensure that mines reach
their full potential. As we said above, an investor should not simply invest
so miners can keep on mining. Part of a professional miner's competence
is to ensure he has the backing of investors who want a reward for their
investment. So earnings and dividends do count!

In conclusion we do suggest that provided the above principles are followed
we do like gold shares above gold itself until the gold price shows it will
climb significantly. Below are our personal favorites - Subscribers-only

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influential gold price factors across the globe, so as to truly understand
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